Sri Lanka could face significantly tighter external refinancing conditions during the next five years, which would quickly lead to much weaker debt affordability, especially if the currency were to depreciate at the same time, Moody’s Investors Service said today.
Moody’s Investors Service said the credit profile of Sri Lanka (B1 negative) is supported by the authorities’ progress in implementing their reform programme, which entails fiscal consolidation and a build-up of foreign exchange reserves.
Sri Lanka also benefits from moderate per capita income levels and stronger institutions than those of many similarly rated sovereigns.
Credit challenges include high Government debt, very low debt affordability and a fragile external payments position, Moody’s said.
Under its IMF Extended Fund Facility programme, the Government is committed to broadening and deepening its revenue base, strengthening the credibility and effectiveness of monetary policy, implementing liability management strategies, and pursuing legislation that ensures deficit and debt consolidation efforts endure after the programme ends in June 2019.
“The negative outlook on the sovereign rating reflects our view that Sri Lanka’s credit profile is dominated by the Government’s and country’s elevated exposure to refinancing risk. Sri Lanka could face significantly tighter external refinancing conditions during the next five years, which would quickly lead to much weaker debt affordability, especially if the currency were to depreciate at the same time,” Moody’s said.
Moody’s said that the negative outlook signals that an upgrade is unlikely.
“We would consider returning the outlook to stable should we conclude external and domestic refinancing risks were likely to diminish. That conclusion could be prompted by a faster and more sustained buildup of non-debt-creating foreign exchange inflows than we currently expect, the demonstrated effectiveness of liability management strategies to smooth and lengthen maturity payments and, over time, significant fiscal reforms that markedly improve fiscal strength,” Moody’s said.
Moody’s also noted that they would consider downgrading the rating if they were to conclude external and domestic refinancing capacity will not improve, and Sri Lanka was likely to face difficulties in refinancing its domestic or external debt affordably. Evidence that the implementation of key policies – including further fiscal consolidation, monetary policy independence from fiscal developments, and the diversification of financing sources or liability management – is not effective would likely negatively affect Sri Lanka’s access to and cost of finance.
A marked weakening in reserve adequacy from already low levels, and a halt or reversal in fiscal consolidation that raised the prospect of higher government debt and prevented the expected decline in gross borrowing requirements could also prompt a downgrade, Moody’s said.
Moody’s said the credit analysis elaborates on Sri Lanka’s credit profile in terms of economic strength, institutional strength, fiscal strength and susceptibility to event risk, which are the four main analytic factors in Moody’s Sovereign Bond Rating Methodology.